Quietly, without a great deal of fanfare the roles of Chief Financial Officers throughout the corporate landscape of North American business have changed. For years this was a mostly a backward-looking support position. Accounting, managing cash flow, record keeping, tax preparation, governmental regulations and related tasks served as the primary focus. But, things changed.
Perhaps it was the Great Recession, the threat of jail time for executives following Sarbanes-Oxley litigation tied to accounting catastrophes like Enron and Worldcom or the newly discovered power of forward-looking analytics, but major corporations began looking at their financial leaders as more than just staff accountants and bookkeepers. As a group, CFOs have stepped into a new power position impacting their organization’s behavior in every department. And, often driving profits to whole new levels.
Distributors seldom serve as the vanguard of business trends. Taking a slow, conservative approach, applying subtle changes, and gently moving toward new business practices appeals to the distributor appetite. When it comes to financial matters, most distributors are even slower to make sweeping changes. Several root causes exist for this phenomenon built into the distributor model. Let’s explore a few.
First and perhaps foremost, very few distributor leaders come from an accounting background. The most common career path for distributor leadership comes via a career in sales. And, even though these folks possess business street sense, many privately confide they struggle with the financial side of their business. Most have learned to read their company’s balance sheet, but, aside from growing top-line sales, few understand the nuances of eking out new profit dollars. Further, historically the CFO of most distributor organizations come without detailed connections in the wholesale industry. Networking amongst the lead financial people of our industry is superficial at best. I believe upping the ante in the financial department holds the key to building better businesses. The time of the Attack CFO has come.
Better Financial Modeling
If you are a distributor working without a real budget, the time has come for you to begin thinking about 2016. Far too many distributors develop sales goals but neglect building a working budget document. A budget should cover each of the following:
- Gross margin projections on a month-by-month basis. Many folks fail to factor seasonality and monthly business trends into their planning process. Is it really reasonable to assume the sales totals for next year will be a linear divide of the projected sales and gross margin numbers?
- A breakdown of personnel expenses by month. This should include bonuses, commissions and other costs, as well as detailed listing of salary increases as they take place. In instances where commissions are paid on a quarterly basis, a set-aside should show the costs so the end of a quarter does not result in an ugly surprise.
- Equipment and building improvements. This should cover things like upgrades to the computer system, laptops, building improvements, office furniture and anything else required to keep the operation running.
- A review of vehicle expenses. If you have cars on lease, will there be a mileage charge at the time of turning them in? Will the next car be more expensive to lease than in previous years? The same principle applies to trucks and other delivery vehicles.
- Marketing and meeting expenses. Many distributors sponsor events throughout the year, and some of them are quite expensive. Have you set a marketing budget that reflects the cost of the event?
- Occupancy charges. Does your budget cover the rent, taxes and other occupancy charges that will impact your cost of doing business?
The budget needs to be a living document with monthly visits to analyze areas where the organization leads or lags projected spending and profitability. To further illustrate the point, let’s review a common scenario.
Top line sales are growing, and nearly all of the old indicators point to the need for a new salesperson. However, gross margin has not kept up with the last year’s pace. Adding a new sales territory creates a number of new expenses (personnel, car and computer). What is the true cost of adding a person? Will the new hire pull down operating profits to an unacceptable point? Or, is it possible to pull money earmarked for other expenses into the personnel costs? Was the growth based on a one-time event or the result of an ongoing market improvement? What might be done to improve the overall gross margin situation? Only with a well-thought-out budget can sound decisions be made. You can’t rely on gut-level, data-free decisions and expect to manage your company successfully for very long.
Building Financial Analytics
Nothing enhances the CFO’s ability to create long-term strategic business value like analytics. A working budget serves as the financial GPS, giving company leadership a clear understanding of the present location. Analytics point to future direction and allow the distributor’s management team to propel the business to stronger performance.
What kind of analytics might be of value? The answer is often tied to the circumstances of the distributor organization, but let’s explore several examples. Payroll expenses are the single largest outlay in the distributor’s budget and account for somewhere between 54% and 59% of total gross margin, according HARDI Profit Benchmarking reports published by the Heating Air-conditioning & Refrigeration Distributors International association.
Obviously, steering the company to a lower payroll expense can improve bottom-line performance. For instance, distributors performing in the high-profit quartile have figured out how to build processes that get more done with fewer people. At the time of each new hire, managers should know how their company aligns against other distributors. And, CFO leadership must stress the importance of maintaining or improving against the current percentage.
Gross margin is the lifeblood of every wholesale business, and the CFO must serve up a continuous stream of analytics around this topic. Current gross margin performance by customer type, salesperson and branch should be monitored, measured and predicted into the future. Further, an attack CFO will analyze customer types based on not only gross margin but also on cost of doing business.
While many experts question the validity of Activity Based Costing (ABC), Al Bates with Profit Planning Group, Boulder, Colo., believes 50% the typical distributor’s customer base actually costs the distributor money. Purely gut-level guesses aside, most distributors struggle to identify the customer groups that negatively impact their profitability. Again, the CFO can provide the analytics necessary to make more informed judgments.
Operational decisions call for financial oversight. Because many distributor operations leaders have risen through the ranks of their company, they often fail to take a critical look at the efficiencies of their operation. For example, we recently visited a distributor who ran several delivery trucks that made frequent stops to drop off one or two low-cost parts. When asked why these small packages weren’t simply sent out via UPS, the warehouse manager said, “It’s free to use our truck, but UPS can cost four dollars.” Clearly, this demonstrated a lack of understanding on the costs of operating a truck. And, correcting and educating against this type of thinking falls squarely on the CFO via analytics.
Financial Intelligence for the Organization
In a world where the boss sometimes struggles to thoroughly understand the financials, it should come as no surprise that many line managers don’t understand the financial impact of their decisions. An Attack CFO must demand a place in every manager’s meeting. It’s their responsibility to make absolutely certain others understand how their actions can impact the company’s profitability. To this end, here are some common points to explore with your own team.
- Does everyone in your organization understand that distribution is a 2% to 3% industry and appreciate the ramifications of the distributor model?
- Do your salespeople comprehend the cost of passing on “good buddy” pricing without understanding the impact of margin on the bottom line?
- Do your sellers understand that special orders with massive administrative cost and incoming freight need to be offset with higher gross margins?
- Does your team understand how much it costs to process an order?
- Have you personally explored the options of employing a pricing process like that offered by David Bauders of Strategic Pricing Associates, Cleveland?
- Does your purchasing team understand what constitutes a good deal on preseason loading programs?
- Do you measure and track freight costs with the goal of driving expense out of your system?
- Are you providing tools for your team to evaluate and maximize back-side rebates and other growth incentives?
Are you an Attack CFO?
If you are the CFO, whether in title or by job duties, now is the time to evaluate your place in the future. I would like to load your mind for the drive home this very day. Instead of catching up on the news or grooving to your favorite music, contemplate how you might be able to go on the attack. Reflect on the areas that could help improve your team’s profitability. And, if you are thinking it’s not my job, allow me to offer up a quote from Paul Mandell of the Consero Group, Bethesda, Md., in Forbes.com:
“There’s been an evolution in America in terms of the CFO. The CFO is increasingly being called upon to weigh in much more on strategic decisions involving the company, including everything from transactions to providing assessments of emerging markets and analyses that go far beyond looking at the books and determining whether there will be enough cash to support investment.”
Let the attack begin…